European Vacation: It's Currency Crisis Season -- Again

Tail risk from Europe could be the straw that breaks the backs of the Dow and S&P.

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Flip-flops, sunscreen, and laissez-faire European policymakers are the new de rigueur summertime accessories. It's only a matter of time before our friends to the East stumble away from Mediterranean beaches, golden suntans intact, to protest some unanticipated upheaval on the steps of some broken government somewhere in the European Union.

One by one, Europe's political elite conveniently arrange their schedules so that no business can be accomplished until September's first cool breeze graces the continent. How quickly we forget about previous summers, where "Ms. Europe" Angela Merkel refused to comment on the precipitous decline of the euro currency -- at least until after her Vitamin D quota was met. Surely even she must've found the weakened purchasing power of the euros in her holiday kitty disheartening. And to suggest that this seasonality could be a result of the lessened political coverage is as unconscionable as it is blasphemous.

A technical look at the chart of the euro (represented by CurrencyShares Euro Trust (NYSEARCA:FXE), EUR/USD) has many traders on edge. A toppy head & shoulders pattern is easily discerned in the daily chart dating back to last July's bottom in the pair. Those with longer memories dating to 2006 should notice an ever tighter consolidation pressuring the currency towards all-important support just below $1.20 Should this handle be given to the bears, the fate of Europe's currency union could be in serious danger of survival.

Last year, Dennis Gartman and "Dr. Doom" Muriel Roubini screamed fire in the euro theater. Like many great traders, it's fair to say they may not have been wrong, they were just early. The resounding thud of shushed currency pundits is an eerie juxtaposition to today's en vogue bond vigilantes. There's far more money to be made in the EUR/USD dropping 50 big figures than with 100-basis-point moves in the 10-year Treasury yield (represented by CBOE Interest Rate 10-Year T-Note (INDEXCBOE:TNX) and iShares Barclays 20+ Year Treasury Bond ETF (NYSEARCA:TLT)). The game is, and always has been, one of distraction. Every action movie is the same: An explosion in an abandoned building summons the attention of police and media. Meanwhile the real mission is underway across town, where our anti-hero can carry out his work without duress, knowing there's no one looking over his shoulder. Think about it: No one mentioned the Japanese yen's recent drop until Paulson announced he had already banked a cool billion (for at least the second time in his career). It's so simple.

The euro currency's strength has long been a vital barometer for the health of US equity markets. In the most basic form it works like this: As the euro rises against the USD, euros can purchase more USD and therefore more US equities. In bull markets past, trading S&P futures (ES) was as easy as watching a tick chart of the euro and monitoring ES oscillation in lockstep. As of last year, the decoupling is more noticeable, but still very much correlated. The takeaway? Tail risk from Europe could be the straw that breaks the backs of the Dow (INDEXDJX:.DJI) and S&P (INDEXSP:.INX). America and the world can survive a managed breakup of the EU's single-currency union. Whether or not our equity markets and central bank can stymie disaster in the hocus-pocus economy du jour is another story.